Income Tax Appellate Tribunal - Pune
Cummins India Limited, Pune vs Dy. Cit, Circle-1(1), Pune, Pune on 3 March, 2017
आयकर अपील�य अ�धकरण पुणे �यायपीठ "ए" पुणे म�
IN THE INCOME TAX APPELLATE TRIBUNAL
PUNE BENCH "A", PUNE
सु�ी सुषमा चावला, �या�यक सद�य एवं �ी आर. के. पांडा, लेखा सद�य के सम�
BEFORE MS. SUSHMA CHOWLA, JM AND SHRI R.K. PANDA, AM
आयकर अपील सं. / ITA No. 115/PUN/2011
�नधा�रण वष� / Assessment Year : 2006-07
Cummins India Limited,
Kothrud,
Pune - 411038 .... अपीलाथ�/Appellant
PAN: AA ACC7258B
Vs.
The Dy. Commissioner of Income Tax,
Circle - 1(1), Pune .... ��यथ� / Respondent
अपीलाथ� क� ओर से / Appellant by : S/Shri A.V. Sondhe,
Ketan Ved and Amit Singhal
��यथ� क� ओर से / Respondent by : S/Shri S.K. Rastogi and
Suhas Kulkarni
सुनवाई क� तार�ख / घोषणा क� तार�ख /
Date of Hearing : 05.12.2016 Date of Pronouncement: 03.03.2017
आदे श / ORDER
PER SUSHMA CHOWLA, JM:
This appeal filed by the assessee is against the order of DCIT, Circle 1(1), Pune, dated 29.11.2010 relating to assessment year 2006-07 passed under section 143(3) r.w.s. 144C(13) of the Income-tax Act, 1961 (in short 'the Act').
2. The assessee has raised the following grounds of appeal:-
A. Transfer Pricing Adjustment:2 ITA No.115/PUN/2011
Cummins India Ltd.
1 .1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in making an adjustment amounting to Rs.40,64,87,070/- to the value of international transactions entered into by the Appellant with its Associated Enterprises pertaining to export of IC engines, payment of royalty and technical know-how fees, procurement support services, receipt of commission as well as transactions relating to interest received on extended credit period offered on exports.
B. International Transaction relating to export of IC Engines
2. Rejection of benchmarking done by the Appellant:
2.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in rejecting the "aggregation approach" followed by the Appellant for benchmarking of international transactions in respect of manufacturing function of the Appellant.
2.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in accepting the benchmarking done by the Transfer Pricing Officer ["TPO"] and stating that benchmarking done by the Appellant is not reliable.
3. Inappropriate issue of two show cause notices
3.1 The learned DCIT, pursuant to the direction of the learned DRP, erred in law and on the facts and in circumstances of the case in issuing two show cause notices.
4. Inappropriate comparison of profitability of "export to Associated Enterprises (AEs)" and "domestic sales" ignoring differences in Functions, Assets and Risks (FAR) and comparison of controlled transactions with controlled transactions 4.1 The learned DCIT pursuant to the directions of the learned DRP erred in law and on the facts and in circumstances of the case in rejecting the external comparable companies selected by the Appellant for benchmarking the manufacturing function.
4.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in comparing segmental profitability earned by the Appellant from "export to AE" and "domestic sales" ignoring product differences, differences in markets as well as differences in the functions, assets and risks (FAR). 4.3 The learned DCIT erred in law and on facts and in circumstances of the case in comparing profitability between "exports to AEs" and "domestic sales". This is a comparison between controlled transactions, which is against the transfer pricing regulations in India, which stipulates comparing controlled transactions with uncontrolled transactions.
5. Inappropriate approach adopted by the TPO by ignoring interest received on extended credit while computing segmental profitability of export to AEs 5.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in ignoring the interest received by the Appellant for extended credit facility allowed to 3 ITA No.115/PUN/2011 Cummins India Ltd.
AEs while computing the segmental profitability of export to AEs. 5.2 The learned DCIT pursuant to the direction of the learned DRP erred in law and on the facts and in circumstances of the case in disregarding that if interest is not charged on extended credit period allowed to AE, then selling price would be on higher side.
6 Inappropriate allocation of administrative expenses and selling & distribution by the TPO 6.1 The learned DCIT erred in law and on the facts and in circumstances of the case in not accepting the allocation of administrative, selling and distribution expenses carried out by the Appellant and which is based on generally accepted costing principles and the same methodology has been historically and consistently followed by the Appellant over the years.
6.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in allocating administrative expenses and selling and distribution expenses on the basis of sales.
7 Inappropriate approach adopted by TPO in application of net profit to cost as Profit Level Indicator (PLI) 7.1 The learned DCIT erred in law and on facts and in circumstances of the case pursuant to the directions of the learned DRP in considering PLI as "net profit to total cost" as against "net profit to sales" as selected by the Appellant without providing cogent reasons.
8. Benefit of the variation / reduction of 5 percent from the arithmetic mean 8.1 The learned DCIT pursuant to the directions of learned DRP has erred in law and on the facts and in circumstances of the case in confirming the computation of arm's length price undertaken by the TPO without considering lower +/- 5 percent range from the price computed based on arithmetic mean as provided in proviso to Section 92C (2) of the Act. C. International Transaction relating to Payment of Royalty
9. Inappropriate approach adopted by the TPO for benchmarking payment of royalty to associated enterprises 9.1 The learned DCIT erred in law and on facts and in circumstances of the case pursuant to the directions of the learned DRP, in rejecting the aggregation approach in respect of manufacturing function followed by the Appellant for benchmarking the international transaction relating to payment of royalty.
9.2 The learned DCIT erred in law and on the facts and circumstances of the case pursuant to the directions of the learned DRP, in benchmarking the international transaction of payment of royalty by comparing the same with the payment of royalty by other group entities, i.e. with another controlled transaction.
9.3 The learned DCIT pursuant of the directions of the learned DRP, erred by overlooking the approval received from Secretariat for Industrial Assistance ["SIA"], Department of Industrial Policy and Promotions, 4 ITA No.115/PUN/2011 Cummins India Ltd.
Government of India, in respect of technology transfer agreement. Further the decision of the Honourable ITAT Pune in this regard is ignored.
9.4 The learned DCIT pursuant of the directions of the learned DRP erred in facts and circumstances in dissecting the royalty payment in two categories although different rates of royalty are as per a technology transfer agreement with one associated enterprise as separate international transactions and benchmarking only the royalty rate of 8% on net sales separately and not the other rates of royalty. 9.5 Without prejudice to above, once the adjustment is made to international transaction of "export to AE" by comparing the net profit margin earned in export segment and domestic segment, no separate adjustment is required for payment of royalty, as the royalty paid has already been considered while calculating the net profit margin of export and domestic segment.
D. International Transaction relating to payment of Technical Know-
how
10. Inappropriate approach adopted by TPO in benchmarking payment of technical know-how fees to associated enterprises 10.1 The learned DCIT erred in law and on facts and in circumstances of the case pursuant to the directions of the learned DRP, in rejecting the aggregation approach in respect of manufacturing function followed by the Appellant for benchmarking the international transaction relating to payment of technical know-how fees.
10.2 The learned DCIT pursuant to the directions of the learned DRP erred in rejecting TNMM followed by the Appellant for benchmarking the payment of technical know-how.
10.3 The learned DCIT erred in facts and in circumstances of the case pursuant to the directions of the learned DRP in determining the value of the international transaction of payment of technical know-how as 'Nil' without applying any of the prescribed methods under section 92C(2) of the Act.
E. International Transaction relating to Procurement Support Services
11. Inappropriate approach adopted by TPO in benchmarking procurement support services provided to associated enterprises 11.1 The learned DCIT erred in law and on facts and in circumstances of the case pursuant to the directions of the learned DRP, in rejecting the aggregation approach in respect of manufacturing function followed by the Appellant for benchmarking the international transaction relating to provision of procurement support services.
11.2 The learned DCIT pursuant to the direction of the learned DRP erred in facts and circumstances of the case in following cherry picking approach in selection of the comparable companies.
11.3 The learned D C IT erred in facts and in circumstances of the case in treating the Appellant as a cost protected entity for rendering procurement support services.
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F. International Transaction relating to receipt of Commission
12. In appropriate approach followed by the TPO in benchmarking receipt of commission from associated enterprises 12.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in rejecting the benchmarking methodology adopted by the Appellant without providing cogent reasons.
12.2 The learned DCIT erred in law and on facts and in circumstances of the case in comparing controlled transaction of receipt of commission with another controlled transaction within the group entities, which is against the transfer pricing regulations in India, which stipulates comparing controlled transactions with uncontrolled transactions. 12.3 The learned DCIT pursuant to the direction of the learned DRP erred in law and on the facts and in circumstances of the case in observing that the associated enterprise should compromise its own profitability to ensure that Appellant earns normal commission/profitability in circumstances where selling price is low.
G. International Transaction relating to interest received on extended credit offered to Associated Enterprises
13. Inappropriate approach adopted by the TPO in benchmarking interest received on extended credit period allowed 13.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in rejecting the benchmarking done by the Appellant in case of interest received on extended credit period allowed to AEs.
13.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in considering Prime Lending Rate of India Banks as a rate for benchmarking the international transaction.
14. Proposed disallowance of incremental provision for New Engine Performance Inspection Fee by the DCIT 14.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in disallowing the incremental provision of Rs.1,31,18,000/- for New Engine Performance Inspection Fees (NEPI).
14.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the price of the engine sold during the year included NEPI obligation and hence accrual of NEPI fees was a proper charge to the Profit and Loss Account of the company in the year of sale. 14.3 Further the learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the provision was made on a scientific basis and it was not excessive / out of proportion as compared to the actual requirements of the Appellant Company.
14.4 The learned DCIT erred in law and on the facts and in circumstances of 6 ITA No.115/PUN/2011 Cummins India Ltd.
the case pursuant to the directions of the learned DRP in not following the ratio of the following decisions:
i) The order of ITAT Pune Bench in ITA No. 510/PNI1998 in the case of the Appellant Company for Assessment Year 1994-95
ii) Rotork Controls India P. Ltd. v CIT (2009) 314 ITR 62 (SC)
iii) CIT V Ericssion Communications P. Ltd. (2009) 318 ITR 340 (Delhi)
15. Proposed disallowance of expenses u/s 14A of Income Tax Act,1961 15.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in disallowing an amount of Rs.15,94,740/- as incurred in relation to exempt income u/s.14A of the Income Tax Act, 1961.
15.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that there was no dominant and immediate connection between the expenditure incurred and exempted income and therefore there cannot be any adhoc disallowance out of general expenses. They erred in not following the ratio of the following decisions:
(a) CIT v Hero Cycles Ltd (2010) 323 ITR 518 (P & H) (b) CIT v Printers House (P.) Ltd (2010) 188 Taxman 70 (Delhi) (c) ITO v M/s. Daga Capital Management Pvt. Ltd. (SB-Mum ITAT) (d) CIT v General Insurance Corporation of India (2002) 254 ITR 203 (Born.) (e) CIT v BSES Ltd. (2008) 113 TT] 227 (Mum.) (f) Space Financial Services v ACIT (2008) 115 TT] 165 (Del.)
16. Proposed disallowance of incremental warranty provision by the DCIT 16.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in confirming the disallowance of the incremental provision for warranty as proposed by the learned Assessing Officer.
16.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the provision made is a definite, contractual and ascertained liability determined on a scientific basis and hence is allowable as a deduction under the provisions of the Income Tax Act, 1961.
16.3 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in holding that the utilizations i.e. the actual expenditure on warranty is much lesser than the provisions made in the last four years and the provisions made by the Appellant Company were clearly excessive and out of proportion as compared to requirement and is not calculated on any scientific / reliable basis. They erred in not appreciating that the Appellant Company had made the provision based on engine-wise detailed scientific working considering past experience which was also filed during the 7 ITA No.115/PUN/2011 Cummins India Ltd.
course of Assessment proceedings.
16.4 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not following the ratio of the following decisions :
i) Rotork Controls India P. Ltd. v CIT (2009) 314 ITR 62 (SC)
ii) CIT V Ericssion Communications P. Ltd., (2009) 318 ITR 34 0 (Delhi)
iii) CIT vis. Vinitec Corporation Pvt. Ltd., (2005) 278 ITR 337
iv) CIT vis. Beema Mfrs. (P) Ltd., (2003) 130 Taxman 400 (Mad.)
v) ITO vis. Wanson [India] Ltd., [1983] 5 ITD 102 (Pune)
vi) Wipro GE Medical Systems Ltd. vis. DCIT, (2003) 81 TT] 455 (Bang.)
vii) IBM India Ltd. v. CIT, (2007) 105 ITD 1 (Bang.)
17. Proposed disallowance out of Deduction u/s. 80IB by the DCIT 17.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in disallowing the deduction u/s. 80IB by allocating a portion of Head Office Expenses and Director's Expenses to the profits of eligible Daman Unit. 17.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the eligible unit of the Appellant Company at Daman was an independent unit managed independently without any interference by other divisions of the Appellant Company and therefore no part of the common expenses / expenses on directors could be attributed to the said unit of the Appellant Company.
18. Proposed disallowance out of depreciation on intangible by the DCIT 18.1 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in disallowing depreciation on intangibles in respect of Global Sourcing Consideration. 18.2 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in disallowing Depreciation on Intangibles of Rs.4,01,86,250/- in respect of Global Sourcing Consideration by following the decision of Mumbai High Court in the case of CIT v Techno Shares & Stocks Ltd. (2009) 225 ITR 337 (Mum.). They erred in not appreciating that the above decision is reversed by the Hon'ble Supreme Court in 2010.
18.3 The learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the Appellant Company had already acquired right to use IPRs related to manufacture of K-38 and K-50 Series Engines in respect of which the consideration was paid.
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18.4 Without prejudice to above, the learned DCIT erred in law and on the facts and in circumstances of the case pursuant to the directions of the learned DRP in not appreciating that the Global Sourcing consideration represented discount on the value of proposed / future sales in the subsequent period of five years and the pro rata discount allowable for the relevant previous year worked out at Rs.4.55 crores on the actual sales for the relevant previous year which should have been allowed as a revenue expenditure.
18.5 Without prejudice to above, they erred in not allowing amortization @ 1/5th of the total expenditure on global sourcing consideration every year for the specified period of five years for which the Agreement was entered into.
19. Initiation of Penalty Proceedings 19.1 The learned DCIT erred on the facts and in law in initiating penalty proceedings under section 271(1) (c) of the Act.
20. Each one of the above grounds of appeal is without prejudice to the other.
3. The first issue raised in the present appeal is against transfer pricing adjustment made by the Assessing Officer / Dispute Resolution Panel (DRP) amounting to Rs.40,64,87,070/- on account of international transaction entered into by the assessee with its associate enterprises pertaining to export of IC Engines, Payment of royalty and technical know-how fees, procurement support services, receipt of commission as well as transaction relating to interest received on extended credit period offered on exports.
4. Briefly, in the facts of the case, the assessee had furnished return of income declaring total income of Rs.210,40,80,385/- on 23.11.2006. The case of the assessee was selected for scrutiny. In view of various international transactions detailed in the audit report in Form 3CEB, reference under section 92CA(1) of the Act was made to the Transfer Pricing Officer (TPO) . The TPO noted that the assessee was 51% owned subsidiary of Cummins INC, USA and the balance equity was held by Kirloskar group, the Indian public and various financial institutions. The company was engaged in the manufacture and sale of IC Engines for power generation and industrial application in the domestic 9 ITA No.115/PUN/2011 Cummins India Ltd.
market. Further, it manufactures and sold IC Engines and components for exports. The assessee was purchasing spares by way of imports for re-sale in the domestic market. The details of international transactions entered into by the assessee are enlisted under para 5 at page 2 of the TPO's order and the activities were divided into (a) manufacturing activity, (b) activity carried on by the low horsepower division, (c) sourcing activity, (d) business services and (e) financing activity. The TPO show caused the assessee since he was of the view that each of the transactions entered into by the assessee were different in its nature and scope and as per the TP Regulations, each of the said transactions should have been benchmarked separately. The TPO was of the view that aggregation of the transactions is not to be applied and the transactional profit method should ideally be applied on transaction to transaction basis. However, in appropriate situations, transaction may be grouped on aggregate basis. The TPO thus, was of the view that aggregation of the aforesaid transactions and benchmarking them together, following TNMM method was not acceptable. The TPO in the first show cause notice was of the view that the assessee was specialized in manufacturing internal combustion engines (IC engines), which were used in variety of business segments. The assessee was manufacturing engines from 60 Horse Power to 2700 Horse Power, operating on diesel, natural gas and duel fuel. The TPO thus, was of the view that the assessee was not manufacturing standard product but was manufacturing on customer needs, engines of specific Horse Power as may be suitable. Such IC engines manufactured by the assessee were sold in the domestic market as well as exported to associate enterprises, wherein the domestic sales to third parties were at Rs.609.63 crores and receipts from exports of engines to associate enterprises was Rs.465.15 crores. The TPO further noted that total receipts from exports to associate enterprises included 10 ITA No.115/PUN/2011 Cummins India Ltd.
sum of Rs.4.01 crores towards interest on extended credit. It was further seen that the gross margins to sales in respect of third party sales stood at 21.33% compared to 16.77% gross margins excluding the amount of interest received on extended credit, was generated from exports to associate enterprises. The TPO in view of the internal comparable available for benchmarking the transactions relating to export of IC engines to associate enterprises, proposed to adopt Cost Plus Method (CPM) for the purpose of benchmarking and also adopting gross profit as Profit Level Indicator (PLI). The assessee was thus, show caused to explain as to why the adjustment should not be made towards international transaction undertaken by the assessee towards export of IC engines to associate enterprises.
5. The next item considered was the payment of royalty. The TPO noted that the rates of royalty paid ranges from 1% to 8% and the total royalty paid was Rs.22,28,27,492/-, out of which royalty amount paid @ 8% of net sales was at Rs.17,13,10,967/-. The TPO worked out the said payment of royalty @ 4.56% on total sales of Rs.375.95 crores. The assessee was asked to give the details in respect of the said payment of royalty, since the royalty was being charged by the associate enterprises for the assessee's export to associate enterprises itself. The TPO noted that group entities were being charged at the rates ranging from 3%-4% and the average rate of royalty worked out to 3.55%. The TPO worked out the excess royalty payment by 1.0566% and suggested an adjustment of Rs.3,96,23,859/-. In respect of technical know-how also, where the assessee had paid sum at Rs.51.35 crores to the associate enterprises and the transaction was benchmarked following TNNM method aggregating the transactions under the manufacturing activity, the TPO noted that this amount was merely an advance and was not debited to Profit & Loss 11 ITA No.115/PUN/2011 Cummins India Ltd.
Account. Since it was not reflected in the Profit & Loss Account, the TPO queried how the same is being benchmarked after having grouped under manufacturing activity. The TPO was of the view that since the amount paid towards technical know-how fees was just an advance, it does not in any way affect the profitability of assessee and thus, it should not be aggregated with the manufacturing activity while following TNNM method.
6. The next item of services provided by the assessee were procurement support services, under which it identified suppliers for procurement of various IC engine parts and components by the associate enterprises and was reimbursed as per the Agreement entered into between the parties. The TPO was of the view that the same has to be benchmarked separately, wherein the PLI worked out to 2.74%, whereas the mean margins of external companies worked out to 8.25%. Since the same was not at arm's length price, the TPO proposed an adjustment of Rs.13.99 lakhs in the show cause notice.
7. The last transaction which was considered by the TPO was the transaction relating to activity of Low Horse Power (LHP) Division, wherein also the assessee had grouped together the internal transaction of import of parts and components of IC engines and export of IC engines; import of generator sets for re-sale and receipt of commission. The first two transactions were termed as LHP Division and the last two transactions were grouped and named as sourcing activities by the assessee. Another transaction was on account of financing activities. The TPO noted that the set of external comparables had been found and mean margins of comparables worked out to 5.99% as against 10.77% of LHP Division. The TPO rejected the aggregation of transactions and proposed an adjustment on account of receipt of commission at Rs.43.24 lakhs 12 ITA No.115/PUN/2011 Cummins India Ltd.
and the financing activities at Rs.1.41 crores. No adjustment was proposed to the LHP division.
8. The TPO vide para 7 after considering the details filed in respect of international transactions relating to export of manufactured IC engines to associate enterprises, issued another show cause notice to the assessee dated 07.10.2009. The TPO refers to the earlier show cause notice issued and the reply of assessee and made observations in respect of international transactions relating to export of manufactured IC engines to the associate enterprises. The TPO took note of the fact that the comparability was made by the assessee at the level of net profit margins in case of exports to associate enterprises of the manufactured IC engines. However, the TPO was of the view that allocation of expenses wherein administrative expenses of Rs.39.35 crores had been allocated against domestic sales, whereas Rs.8.49 crores was allocated to exports to associate enterprises and similarly, in respect of selling and distribution expenses, Rs.19.79 crores was against domestic sales and Rs.8.90 crores in respect of exports to associate enterprises. After perusing the details, wherein allocation was made in respect of certain expenditure but no allocation was made in respect of depreciation, repairs & maintenance, rent receipts and taxes and other expenses, the TPO observed that the expenses were not allocated in the ratio of sales. The assessee was show caused as to why allocation of expenses should not be on the basis of sales of demostic unit and sales to associate enterprises and was also show caused as to why internal comparability should not be taken following TNNM method and why the net margins over total cost be not taken as PLI for such internal comparability and accordingly, why an adjustment of Rs.34.35 crores should not be made in benchmarking the international transactions relating to export of manufactured 13 ITA No.115/PUN/2011 Cummins India Ltd.
IC engines to associate enterprises. The first plea of the assessee of aggregation of transactions relating to export of manufactured IC engines under the head 'manufacturing activity' and benchmarking the said transaction using TNMM method by selecting external comparable companies in similar line of business, was not accepted. The assessee pointed out that there were three major differences in domestic and export sales i.e. product difference, functional difference and risk difference and hence, internal comparison should not be made. The TPO in this regard, rejected the contention of assessee and held that the TNMM method should be applied on transaction to transaction basis though it could be grouped in appropriate situations but in the facts of the case, the same had to be separately valued. In respect of other objections, the TPO observed that net profit margins arising in comparable uncontrolled transactions may be adjusted to take into account the difference between international transactions and the comparable uncontrolled transactions, which could materially affect the amount of net profit in the open market. Accordingly, the plea of assessee in this regard was rejected.
9. The next aspect was the allocation of administrative, selling and distributive expenses and warranty expenses. The TPO after deliberating upon the issue elaborately allocated the same vide para 7.1.2 at page 41 of TPO's order. The TPO re-allocated the administrative expenses and selling & distribution expenses and re-computed the proposed adjustment of Rs.34,17,53,480/- to the international transactions relating to export of IC engines. In respect of payment of royalty, wherein the assessee had paid royalty @ 8% on net sales towards manufactured goods exported to its associate enterprises. The TPO noted the contention of assessee that effective rate of royalty on gross sales of Rs.961.24 crores worked to 2.32%, whereas 14 ITA No.115/PUN/2011 Cummins India Ltd.
the average rate of royalty paid by other companies worked out to 3.5% and hence, the same was at arm's length price, but rejected the same, where the rates of royalty on other group companies were at 3% - 4% for both domestic and exports, whereas in the instant case, rate of royalty was 8%. The TPO was of the view that in case the rate of royalty was up to 5% on net sales, the same were at arm's length price. However, the royalty paid at 8% was very higher. Another aspect noted by the TPO was that Cummins Inc had incurred expenditure of about 3% of sales during the year and if the expenditure was 3% of sales, then he was of the view that royalty @ 3.5% on gross sales as proposed in the show cause notice was more than justified. In view thereof, adjustment of Rs.3,97,23,859/- was made to the international transactions relating to payment of royalty to associate enterprises by the TPO. The TPO also made following additions on account of arm's length price of each of the transactions:-
a) Technical Know -how Fees - Rs.51.35 lakhs First installment paid towards acquisition of Know-how pertaining to KIT engines which for the year under consideration was an advance.
b) Procurement support services - Rs.13.99 lakhs
c) Receipt of commission - Rs.43.24 lakhs
d) Financing activity - Rs.141.51 lakhs
10. The TPO thus, intimated an adjustment of Rs.40,64,87,070/- to total value of international transactions relating to export of IC engines, payment of royalty and technical know-how fees to associate enterprises, procurement support services and receipt of commission as well as transactions relating to interest for extended credit and other transactions. The Assessing Officer asked the assessee to submit as to why the said additions should not be made in its hands. The assessee filed objections before the Dispute Resolution 15 ITA No.115/PUN/2011 Cummins India Ltd.
Panel (DRP), who dismissed the same in entirety. Thereafter, the Assessing Officer made addition in the hands of assessee at Rs.40.64 crores on account of arm's length price of international transactions. The Assessing Officer also adjudicated certain other corporate issues and made the following additions:-
a) NEPI provision Rs.1,31,18,000/-
b) Disallowance u/s. 14A Rs.15,94,740/-
c) Provision of Warranty expenses Rs.4,41,28,000/-
d) Disallowance u/s 80IB(4) Rs.2,94,365/-
e) Depreciation on Intangible Assets Rs.4,01,86,250/-
11. The Assessing Officer had proposed the said additions in its draft assessment order and the DRP rejected the objections of assessee against the said additions and the Assessing Officer in the final order passed under section 143(3) r.w.s. 144C (13) of the Act, made the said additions in the hands of assessee, against which the assessee is in appeal before us.
12. The learned Authorized Representative for the assessee elaborately took us through the show cause notice issued by the TPO i.e. first show cause notice in which he had proposed TNNM method on aggregation transactions. The learned Authorized Representative for the assessee herein pointed out that after receiving the reply of assessee explaining all the issues raised in the show cause notice, the TPO did not propose any addition but issued second show cause notice, wherein he proposed that CPM method may be applied for benchmarking international transactions of export of IC engines and payment of royalty. He pointed out that the TPO has mislead himself in comparing the two activities undertaken by the assessee i.e. manufacturing of items and sale to domestic market with the manufacturing and sale to associate enterprises. He pointed out that wherein, there was difference in the products and there was functional difference and also difference in risk in two activities undertaken by the assessee, there could not be comparison between the same. In any case, 16 ITA No.115/PUN/2011 Cummins India Ltd.
he pointed out that the comparison, if any is to be with Uncontrolled Transactions and not with the controlled transactions. The learned Authorized Representative for the assessee thereafter, referred to third show cause notice issued by the TPO, wherein he referred to allocation of administrative and selling expenses on sales ratio basis. He pointed out that the assessee has applied SAP System and ERP System for allocating expenses, on the other hand, the TP re-allocates the administrative expenses on adhoc basis. He further found fault with the order of TPO in comparing the exports made to associate enterprises by the assessee with its domestic sales and in not applying the margins of comparable companies selected by the assessee to benchmark its international transactions. The learned Authorized Representative for the assessee pointed out that this issue of aggregation and re-allocation of expenses has arisen only in the instant year, whereas in the preceding year and also in the succeeding year, the method adopted by the assessee has been accepted in toto. The learned Authorized Representative for the assessee pointed out that in the preceding year when the entity Cummins India Ltd. was carrying on of export of components and also IC engines but was not involved in manufacturing, then the Tribunal in Cummins India Ltd. Vs. Addl. CIT, relating to assessment year 2005 -06, order dated 31.12.2014 (2015) 53 taxmann.com 53 (Pune-Trib.) had accepted the principle of aggregation of transactions. He pointed out that the said concern got merged with the assessee and all the transactions were undertaken by the assessee. Our attention was drawn to the list of international transactions undertaken by the assessee which are enlisted in the order of TPO and it was pointed out that the activities undertaken were overlapping, where the import of engine parts and components was for both the exports and domestic consumption. Similarly, the royalty payment was for providing procurement 17 ITA No.115/PUN/2011 Cummins India Ltd.
support services to associate enterprises and also for IT support services to others. The learned Authorized Representative for the assessee pointed out that the TPO had accepted the aggregation but was comparing with the RPT components. He stressed that in case the aggregation transaction is accepted, then the cost would include both. He also pointed out that while applying the CPM method, the TPO had used gross margins as PLI, whereas while applying the TNMM method, net margins were to be applied. Reliance was placed on series of cases in this regard.
13. The learned Departmental Representative for the Revenue on the other hand, pointed out that the TPO had finally applied TNMM method with net margins but had compared the same with the internal comparables available by way of domestic sales. Our attention was also drawn to the list of administrative expenses, where the cost of depreciation, rent, rates and repairs & maintenance were all debited to the domestic margins. The learned Departmental Representative for the Revenue questioned the basis of allocation of expenses by the assessee. He further stated that where the comparables were available internally, then the TPO applied the margins to benchmark the international transactions undertaken by the assessee, which is acceptable. Similarly, where the assessee had not maintained separate books of account and where the activity undertaken was common, then allocation of expenses was also aggregated. He further pointed out that the assessee had imported components which were used for both domestic and export sales and the TPO had not made any comparison of utilization. He relied on the reasoning of TPO in applying TNNM method with net margins as PLI. 18 ITA No.115/PUN/2011
Cummins India Ltd.
14. We have heard the rival contentions and perused the record. The assessee is engaged in manufacture and sale of IC engines for power generation and industrial applications in the domestic market and it also manufactures and sells IC engines and components for exports. The assessee imports engine parts and components which in turn, were grouped for utilizing in the manufacturing activity undertaken by the assessee both for domestic and for exports. During the year under consideration, the assessee had entered into various international transactions which are as under:-
Sr. No. International transaction Amount Rs. Method Adopted A Manufacturing Activity 1 Import of Engine Parts and 2,34,27,95,061/- TNMM components 2 Export of manufactured IC Engines 4,61,15,04,183/- TNMM 3 Export of manufactured and bought 21,21,95,671/-
out components 4 Payment of Royalty 20,01,38,867/- TNMM 5 Provisions of Miscellaneous 2,60,98,683/- TNMM Services (Procurement Support Services) 6 Receipt of IT Support Services 5,16,56,441/- TNMM 7 Design services 2,52,66,373/- TNMM 8 Payment of Technical Know -how 51,35,000/- TNMM fees 9 Rendering of Audit Services 1,21,057 10 Rendering of HR Services 5,983/-
11 Import of Fixed Assets 7,62,821/-
12 Payment of Global Sourcing NA
Consideration
B Activity carried on by the Low Horse Power Division
13 Import of parts and components of 1,93,33,503/- TNMM
IC Engines (LHP Division)
14 Export of IC Engines (LHP Division) 21,80,62,687/- TNMM
C Sourcing Activity TNMM
15 Import of Gas Gensets 3,72,26,421/- TNMM
16 Receipt of Commission 55,54,281/- TNMM
D Business Services
17 Fixed Asset and Cash Management 43,30,309/- TNMM
Services
E Financing Activity
18 Receipt of Interest for extended 4,00,97,000/- Comparable
credit-period facility Uncontrolled
Price
Method
19
ITA No.115/PUN/2011
Cummins India Ltd.
15. The assessee had applied TNNM method to benchmark its international transactions by aggregating closely and inter-linked transactions under similar activities and had found the transactions to be arm's length price. The TPO on the other hand, segregated various transactions and benchmarked the same and found it to be not at arm's length price and hence, addition in the hands of assessee. On the other hand, the claim of assessee was that the operations undertaken by it were predominantly relating to manufacture of internal combustion engines which in turn, are used for various applications and all the transactions should be aggregated as done by the assessee in its transfer pricing study report and the same be accepted to be arm's length price. The first issue raised by the assessee before us in this regard is as to whether such aggregation should be made in the hands of assessee. The learned Authorized Representative for the assessee in this regard has placed reliance on the ratio laid down by the Pune Bench of Tribunal in Cummins India Ltd. Vs. Addl. CIT (supra) (dated 31.12.2014), which in turn, had followed the ratio laid down in Demag Cranes & Components (India) (P.) Ltd. Vs. DCIT (2013) 30 taxmann.com 364 (Pune - Trib.). The concern Cummins India Ltd. in assessment year 2005-06 before the Tribunal was engaged in after market support for IC engines sold by Cummins entities. The activities consisted of customer support through sale of spare parts of Cummins engines, of Cummins products manufactured worldwide and also by Cummins India Ltd. Various international transactions were undertaken with the associate enterprises and the question which arose before the Tribunal was the aggregation of transactions and application of internal TNNM method. The Tribunal vide order dated 312.2014 held as under:-
"24. The first issue arising in the present appeal is whether in view of the OECD guidelines and the Indian Transfer Pricing provisions, aggregation of transactions could be made or not. We find that Pune Bench of the Tribunal in Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT (supra) had 20 ITA No.115/PUN/2011 Cummins India Ltd.
elaborately considered the OECD guidelines under Chapter - III and also the guidance Notes issued by the Institute of Chartered Accountants of India on transfer pricing in para 13.7 and had held as under:-
"30. We have carefully considered the rival submissions. Section 92B of the Act provides the meaning of expression "international transaction"
as a transaction between two or more associated enterprises. Rule 10A(d) of the Rules explains the meaning of the expression "transaction" for the purposes of computation of ALP as to include a number of closely linked transactions. Rule 10B of the Rules prescribes the manner in which the ALP in relation to an international transaction is to be determined by following any of the methods prescribed. Shorn of other details, it would suffice to observe that on a combined reading of Rule 10A(d) and 10B of the Rules, a number of transactions can be aggregated and construed as a single 'transaction' for the purposes of determining the ALP, provided of course that such transactions are 'closely linked'. Ostensibly the rationale of aggregating 'closely linked' transactions to facilitate determination of ALP envisaged a situation where it would be inappropriate to analyse the transactions individually. The proposition that a number of individual transactions can be aggregated and construed as a composite transaction in order to compute ALP also finds an echo in the OECD guidelines under Chapter III wherein the following extract is relevant:-
"Ideally, in order to arrive at the most precise approximation of arm's length conditions, the arm's length principle should be applied on a transaction-by-transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. Some long term contracts for the supply of commodities or services; 2. Rights to use intangible property; and 3. Pricing a range of closely linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing of manufacturing know- how and the supply of vital components to an associated manufacturer; it may be more reasonable to access the arm's length terms for the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method. A further example would be the routing of a transaction through another associated enterprise; it may be more appropriate to consider the transaction of which the routing is a part in its entirety, rather than consider the individual transactions on a separate basis."
31. In this background, considering the legislative intent manifested by way of Rule 10A(d) read with Rule 10B of the Rules, it clearly emerges that in appropriate circumstances where closely linked transactions exist, the same should be treated as one composite transaction and a common transfer pricing analysis be performed for such transactions by adopting the most appropriate method. In other words, in a given case where a number of closely linked transactions are sought to be aggregated for the purposes of bench marking with comparable uncontrolled transactions, such an approach can be said to be well established in the transfer pricing regulation having regard to Rule 10A(d) of the Rules. Though it is not feasible to define the parameters in a water tight compartment as to what transactions can be considered as 'closely linked', since the same would depend on facts and circumstances of each case. So however, as per an example noted by 21 ITA No.115/PUN/2011 Cummins India Ltd.
the Institute of Chartered Accountants of India (in short the 'ICAI') in its Guidance Notes on transfer pricing in para 13.7, it is stated that two or more transactions can be said to be 'closely linked', if they emanate from a common source, being an order or contract or an agreement or an arrangement, and the nature, characteristic and terms of such transactions substantially flow from the said common source. The following extract from the said Guidance Notes is worthy of notice:-
"13.7 The factors referred to above are to be applied cumulatively in selecting the most appropriate method. The reference therein to the terms 'best suited' and 'most reliable measure' indicates that the most appropriate method will have to be selected after a meticulous appraisal of the facts and circumstances of the international transaction. Further, the selection of the most appropriate method shall be for each particular international transaction. The term 'transaction' itself is defined in rule 10A(d) to include a number of closely linked transactions. Therefore, though the reference is to apply the most appropriate method to each particular transaction, keeping in view, the definition of the term 'transaction', the most appropriate method may be chosen for a group of closely linked transactions Two or more transactions can be said to be linked when these transactions emanate from a common source being an order or a contract or an agreement or n arrangement and the nature, characteristics and terms of these transactions are substantially flowing from the said common source. For example, a master purchase order is issued stating the various terms and conditions and subsequently individuals orders are released for specific quantities. The various purchase transactions are closely linked transactions.
13.8 It may be noted that in order to be closely linked transactions, it is not necessary that the transactions need be identical or even similar. For example, a collaboration agreement may provide for import of raw materials, sale of finished goods, provision of technical services and payment of royalty. Different methods may be chosen as the most appropriate methods for each of the above transactions when considered on a standalone basis. However, under particular circumstances, one single method maybe chosen as the most appropriate method covering all the above transactions as the same are closely linked." (Underlined for emphasis by us).
32. In this background, we may now examine the facts of the present case. The primary activity of the assessee is to manufacture material handling equipments viz. cranes and hoists. It is seen from the documents placed in the Paper Book that the assessee enters into a single negotiation with the customers, which, inter-alia, includes manufacturing and supply of the material handling equipment, provision of commissioning and installation services, etc. Though the assessee raises different invoices for supply of equipments and separately for erection and commissioning charges, however, it is evident that the negotiations for the same are carried on at one go. In fact, at the time of hearing, it was specifically queried from the learned counsel as to whether the assessee is undertaking installation/commissioning activities independent of its own-supplied material handling equipments. It was clarified that the servicing and commissioning charges are earned only in relation to services performed for own-supplied manufacture/assembled material handling equipments. The aforesaid 22 ITA No.115/PUN/2011 Cummins India Ltd.
factual assertion is not disputed. Factually, it is the activity of manufacturing/assembling of cranes etc. done by the assessee and sales thereof, which brings into play the activities of installation and commissioning of such products. Therefore, it is quite evident that such services are not independent but in-effect are as a result of manufacturing of material handling equipment undertaken by the assessee and as a they arise from a single negotiation with the customers, the source of all such transactions is also to be understood as common.
33. The TPO in this regard has observed that assessee has invoiced separately for such activities and therefore, they have to be understood as different transactions. The TPO has also observed in his order that in a case where profits of each individual transaction can be segregated then the aggregation of transaction is not intended by the transfer pricing regulations. The learned TPO has also referred to the segmental profitability in this regard computed by the assessee during the course of transfer pricing proceedings before him. In our considered opinion, the point made out by the learned TPO is not justified, inasmuch as, separate invoicing of an activity, flowing from a singular contract/ negotiation, would not ipso facto lead to an inference that they are individual/independent transactions. In-fact, it is the nature and characteristic of the activities which would be required to be analyzed having regard to the facts and circumstances of each case as to whether they can be considered as individual/independent transactions or a single transaction for the purpose of transfer pricing regulation. In the present case, as we have noted earlier, it is only on account of the manufacturing activity that the activity of commissioning and installation of the equipment arises and pertinently all the aforesaid activities are negotiated and contracted for at one instance. With regard to the segmental profitability referred by the Assessing Officer, the position has been clarified by the assessee. According to the assessee, in the financial statements affirmed by the Auditors, the activities have been clubbed together in accordance with the Accounting Standards prescribed by the ICAI. It was clarified that the segmental profits were worked out by the assessee only at the asking of the TPO during the proceedings before him. The learned counsel pointed out with reference to the chart in this regard placed in the Paper Book and submitted that the segmental profitability was not computed on the basis of any separately maintained records viz. books of account or vouchers but was computed by undertaking a statistical exercise. The costs were allocated as a proportion of sales/revenues and not an actual basis. In view of the aforesaid fact situation, we do not find that the availability of separate segmental profits in the present case can be a justifiable ground for the TPO to say that the transactions are not 'closely linked' within the meaning of Rule 10A(d) of the Rules. Thus, the activity of installation and commissioning/engineering services is 'closely linked' with the manufacturing activity and deserves to be aggregated and construed as a single transaction for the purposes of determining the ALP as per the method adopted.
34. In view of the aforesaid discussion, in our opinion, the approach of the TPO, in out-rightly rejecting the aggregation of all the transactions itemized at 1 to 7 in para 7 is flawed having regard to the facts and circumstances of the case. Further, it is noticed from the tabulation in para 7 of this order, that the assessee is also rendering marketing services, technical know-how and professional services, etc., which have also been aggregated. For such activities no specific point has been made out by the assessee as to why they can be classified as 23 ITA No.115/PUN/2011 Cummins India Ltd.
'closely linked' transactions for the purposes of Rule 10A(d) of the Rules. Considering the entirety of the facts and circumstances, we are of the opinion that the issue be revisited by the AO/TPO in the light of our aforesaid discussion. The AO/TPO shall take into consideration the pleas and the material sought to be placed by the assessee in the light of the aforesaid discussion and thereafter adopt a combined transaction approach after considering each of the transaction itemized at 1 to 7 as to whether the same are to be bench marked after aggregation or not. Needless to say, the Assessing Officer shall allow the assessee a reasonable opportunity to put forth material and submissions in support of its stand and only thereafter the Assessing Officer shall pass an order afresh on the above aspect in accordance with law. Thus, on this Ground, assessee succeeds for statistical purposes."
25. Similar principle has been laid down by the Delhi Bench of the Tribunal in M/s. Panasonic India Pvt. Ltd. Vs. ITO (supra) and M/s. Intimate Fashions (India) Pvt. Ltd. Vs. ACIT (supra).
26. In view of the ratio laid down by Pune Bench of the Tribunal in Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT (supra), it is held that where number of transactions are closely linked transactions, then the same can be aggregated and construed as a single transaction for the purpose of determining the arm's length price. In case, there is close link exists between the different transactions, the same should be treated as composite transaction and appropriate method should be applied to work out the transfer pricing analysis. Where two or more transactions emanate from common source being an order or contract or an agreement or an arrangement, then such transactions could be said to be closely linked as the nature, characteristic and terms of such transaction substantially flow from the said common source.
27. In the above said background, we analyse the different international transactions entered into by the assessee as pointed out by us in the paras hereinabove. The business of the assessee company was to provide aftermarket support to IC engines sold, in the form of sale of spare parts and rendering of after sales service including warranty administration. The assessee is thus, providing after sales support for engines sold by Cummins India Ltd., Cummins INC, etc. which were under warranty period and also post warranty period. The servicing, repair and annual maintenance contract, warranty period and for post warranty period were the services provided by the assessee for carrying out most of the above said activities. The sale of spare parts was claimed to be the principal activity of the assessee. The repair & maintenance and the warranty administration including services of the IC engines requires the support of the spare parts which were sold by the assessee. Where the assessee was engaged in aftermarket support of engines manufactured and sold by Cummins entities, the question arises whether the sale of spare parts could be categorized separately as a trading activity engaged in by the assessee, which in turn is separate from the activity of doing servicing of the IC engines, their repair and maintenance and also warranty administration i.e. support during the warranty period and also annual maintenance contracts and services during post warranty periods. Another activity engaged in by the assessee was payment for customized parts catalogue, which was also aggregated by the assessee company as part of its international transactions, which were claimed to be linked to the sale of spare parts carried on by the assessee.
28. The assessee during the year under consideration had made exports to its associated enterprises on account of the said spare parts totaling Rs.87,48,479/-. The assessee had also made exports to third parties during the financial year totaling Rs.4,16,326/-. The break-up of the exports to 24 ITA No.115/PUN/2011 Cummins India Ltd.
associated enterprises and third parties are enlisted at pages 200 to 204 of the Paper Book. Admittedly, there was significant difference in the value of exports made to associated enterprises and the exports made to third parties. The explanation of the assessee in this regard was that the exports made to the associated enterprises were on regular basis and were being made to its associated enterprises, which in turn were supplying to the dealers and through them, to the customers. However, the exports to third parties were directly made to the consumers who could select the spares through the catalogue and order the same to the assessee, who was engaged in providing aftermarket support to the IC engines sold worldwide. Further, the claim of the assessee was that the export to third parties was made on urgent basis and hence, the premium was charged and further, the frequency of such transactions was low and consequently, higher margins of profits. The first major activity carried on by the assessee was of import of spare parts to Rs.29.45 crores as against which, the export of spare parts was only Rs.0.87 crores. The payment for IT support received from associated enterprises was Rs.1.09 crores and the payment for access to customized part catalogues was Rs.0.02 crores. Further, the assessee had received Rs.0.76 crores against warranty administration. All these international transactions are linked to the main business being carried on by the assessee and such closely linked transactions are to be analysed in aggregate to determine the arm's length price. The aggregation of the import of spare parts, export of spare parts, IT support services, access to customized parts catalogue and amount received for warranty consideration are inter-related transactions, which were the sourcing activities of the assessee company and have to be aggregated in order to benchmark the international transactions. The assessee had benchmarked the arm's length price of all the transactions by comparing results of the comparable companies which were found to be at arm's length price. The assessee had also furnished the segmental Profit & Loss Account for the exports to associated enterprises and as compared to the export to third parties and percentage of services over total sales in respect of export to associated enterprises works out to 0.2069% and in respect of exports to third parties works out to 0.0098%."
16. The assessee for the year under consideration before us is engaged in the manufacturing activity along with other related activities and had aggregated international transactions as tabulated hereinabove and had benchmarked the international transactions by using TNNM method as most appropriate method by taking external comparables and adopted PLI as operating margins to sales. The TPO on the other hand, had made adjustment after rejecting the claim of aggregation and also while applying the TNNM method had compared the same with internal comparables i.e. domestic sales made by the assessee. Under section 92B of the Act, meaning of expression 'international transaction' is provided i.e. a transaction between two or more associate enterprises. Rule 10A(d) of the Income Tax Rules, 1962 (in short 25 ITA No.115/PUN/2011 Cummins India Ltd.
'the Rules') explains the meaning of expression "transaction" for computing the arm's length price to include number of closely linked transactions. Rule 10B of the Rules prescribed the manner in which the arm's length price is to be determined by following any of the method prescribed. The combined reading of Rule 10A(d) and 10B of the Rules reflect that number of transactions can be grouped and constituted as single transactions for the purpose of determining arm's length price, provided that such transactions are closely inter-linked. Further, even under the OECD Guidelines under the Chapter III, the proposition of aggregation of individual transactions is taken note of. In such background, it emerges that in appropriate circumstances, where there is existence of closely linked transactions, the same could be considered as one composite transaction and for this, common transfer pricing analysis needs to be carried out by adopting most appropriate method. Depending on the facts and circumstances of each case, it needs to be seen as to which transactions are to be held to be closely linked. Applying the said principle to the facts of the present case, where the primary activity of assessee was to manufacture and sell IC engines and components both for domestic market and for exports, then the activity of importing engine parts and components, payment of royalty for getting know-how, provision of miscellaneous service i.e. procurement support services to the associate enterprises to help the sourcing of components, receipt of IT support services, design services and payment of technical know- how fees, etc. is closely linked to the export of manufactured IC engines. The principle of aggregation of closely linked transactions for undertaking benchmarking analysis applying TNNM method has been approved by the Hon'ble High Court of Delhi in Sony Ericsson Mobile Communications India Pvt. Ltd. Vs. CIT reported in 374 ITR 118 (Del). Accordingly, we hold that for benchmarking international transactions, various activities undertaken by the 26 ITA No.115/PUN/2011 Cummins India Ltd.
assessee under the head 'manufacturing activities' need to be aggregated. The Assessing Officer / TPO is directed so.
17. Now, coming to the second related issue arisen to benchmark the international transactions of the assessee. The TPO had issued various show cause notices to the assessee. In the first show cause notice, the assessee was asked to benchmark the international transactions by following TNNM method by taking the margins of comparables of current year. In the second show cause notice, the TPO had proposed CUP method to be applied by taking gross profits as the PLI. In the next show cause notice, the TPO had proposed internal TNNM method to be applied, wherein the benchmarking had to be done by comparing the margins earned by the assessee from exports to associate enterprises in comparison with the margins earned from sales in the domestic market. In the forth show cause notice, certain adjustments were made to the costs i.e. allocation of certain costs to the segmental details of exports division in order to work out the PLI. In this regard, the assessee had elaborately took us through various submissions made before the TPO / DRP and has argued that there is no comparison between IC engines sold in the domestic market and IC engines exported by the assessee. He has also stressed that comparison, if any has to be made with uncontrolled transactions. The assessee pleaded that the two products i.e. manufactured by the assessee are different and are functionally different and also there is difference of risk, hence, they do not fall within FAR analysis. The case of authorities is that the assessee is engaged in manufacture of IC engines which is major activity carried on by the assessee and the said engines were of different capacity. The assessee has stressed that the gross margins earned from sale of IC engines in the domestic market are at variance to the gross margins earned by 27 ITA No.115/PUN/2011 Cummins India Ltd.
the assessee from export of IC engines to associate enterprises. The assessee has also stressed that comparability, if any, is to be made with uncontrolled transactions. Another aspect raised in appeal is that the net profit margins of controlled transactions has to be compared with net profit margins of uncontrolled transactions, whereas the TPO has applied gross profit margins.
18. We find that similar issue of adjustment made on account of arm's length price of international transactions relating to export of manufactured IC engines by considering difference in the gross margins earned by the assessee from sale of IC engines in the domestic market and gross margins earned by the assessee from exports of IC engines to associate enterprises arose before the Tribunal in assessee's own case relating to assessment year 2005-06 in ITA No.594/PN/2013 i.e. Revenue's appeal with CO No.53/PN/2014 and the Tribunal vide order dated 29.01.2016 held that in view of the provisions of Rue 10B(e) of the Rules as well as para 3.26 of OECD Guidelines and various other decisions, net profit margins of controlled transactions had to be compared with net profit margins of uncontrolled transactions. The Tribunal also held that comparing of gross margins was not envisaged under the IT Rules. Reliance was placed on the findings of CIT(A) in this regard, which are reproduced under para 17 at pages 10 to 11 of the Tribunal's order. The perusal of same reflects that the finding of CIT(A) which have been upheld by the Tribunal are that it has not been demonstrated by the assessee that there was material variation in margins of each product type, where all the manufactured products of the assessee fell into the basket of IC engines. The plea of assessee that it undertook functionally assumed more risk in the domestic market were rejected and it was observed that unless the enterprise demonstrates with relevant facts as to why it earned lower profits while exporting to associate enterprises as 28 ITA No.115/PUN/2011 Cummins India Ltd.
against domestic market, the assessee's argument on this issue could not be considered. Therefore, the said contention of assessee was rejected. However, on the issue of PLI, the CIT(A) held that the TNNM method refers to net margins and not gross margins and comparing of gross margins was not envisaged under the Income Tax Rules. The Tribunal in view of the detailed reasoning of CIT(A) observed that the addition made by the Assessing Officer on account of division of difference in gross profit margins by the Assessing Officer as against difference in net profit margins between sales to associate enterprises and sales in domestic market, no addition is warranted. The Tribunal decided the issue as per provisions of Rule 10A(d) of the Rules and deleted addition. Applying the said principle, we direct the Assessing Officer / TPO to re-compute the adjustment, if any, in the hands of assessee on account of international transactions. It may be pointed out herein itself that the adjustment was made in the hands of assessee in HHP Division only and no adjustment was made in LHP division.
19. Before parting, we may point out that though the assessee had filed Cross Objections against the appeal filed by the Revenue, but no issue has been raised against finding of CIT(A) that all manufactured products of the assessee fell into basket of IC engines and therefore, it was unlikely that there will be material variation in margins of each product type. The CIT(A) had also held that unless the enterprise demonstrates with relevant facts as to why it earned lower profits while exporting to associate enterprises as against domestic market, assessee's arguments on this issue could not be considered and the contention of assessee on this ground was not accepted by the CIT(A). The CIT(A) thereafter, decided the issue on the margins to be applied whether on the gross or net and deleted the addition. The appeal of Revenue was 29 ITA No.115/PUN/2011 Cummins India Ltd.
dismissed. The perusal of order reflects that the grounds of appeal No.2, 3 and 5 of Cross Objections were not pressed by the assessee, wherein grounds of appeal No.2, 3 and 2.4 were against the order of CIT(A) in not considering the use of external comparable companies selected by the assessee for benchmarking the manufacturing activity of HHP division. The ground of appeal No.2.5 was against the stand of Assessing Officer in comparing the segmental profitability of assessee's export to associate enterprises segment and domestic sales segment. The ground of appeal No.2.6 is on the difference in FAR analysis of sales in export market than in domestic market. However, all these grounds of objections were not pressed by the assessee before the Tribunal and the same were dismissed while deciding the appeal relating to assessment year 2005-06 (order dated 29.01.2016). Further, the learned Authorized Representative for the assessee had placed reliance on various decision on difference between the sales in export market as compared to the sales of domestic market and difference in their margins. However, in view of withdrawal of similar issues by the assessee before the Tribunal in earlier year, we are not referring to the ratios laid down by the said decisions.
20. Another linked issue raised by the assessee is while computing the PLI and the cost have been re-worked by the Assessing Officer / TPO by comparing with administrative expenses for domestic segment and the exports. The assessee claimed that while preparing segmental profitability, it had applied generally accepted Costing Principles to allocate expenses. However, the Assessing Officer / TPO had rejected the same without any basis and had used the ratio of sales for allocating the said expenses and re-worked the cost. The assessee is aggrieved by such re-working of the cost which are to be considered while determining the operating margins. 30 ITA No.115/PUN/2011
Cummins India Ltd.
21. The perusal of details of administrative expenses reflects that certain expenses i.e. like depreciation, rent, rates, repairs & maintenance, taxes and other expenses have not been allocated at all to the export division, by the assessee. The assessee claims that depreciation and other expenses on plant & machinery were already included in the cost of goods sold and the non- allocation if any, does not affect cost. In the totality of the above said facts and circumstances, we find no merit in re-allocation of administrative expenses and selling & distribution expenses by the Assessing Officer / TPO.
22. The next issue raised by way of ground of appeal No.7 is the methodology adopted by the TPO in application of net profit to cost as PLI. The case of assessee is that where selling price of component manufactured by it derives the profitability and not the cost of components utilized for manufacturing activity, the PLI should be adopted as net profit to sales and not net profit to cost. We find merit in the plea of assessee in this regard that where the assessee is engaged in the manufacture of components and the main aim of undertaking was to sell the said components, then it is the sales which derive the profitability and not the cost of components. Accordingly, while determining the PLI, the TPO is directed to adopt net profit to sales in order to benchmark the international transactions. Hence, the ground of appeal No.7 is allowed.
23. The ground of appeal No.1 is general and hence, the same is dismissed. The ground of appeal No.2 against aggregation, is allowed. The ground of appeal No.3 against issue of two show cause notices for the same transaction is dismissed. The ground of appeal No.4 against comparability of profitability of export to associate enterprises and domestic sales is dismissed as indicated 31 ITA No.115/PUN/2011 Cummins India Ltd.
above. The issue in ground of appeal No.6 of allocation of administrative and other expenses is allowed and ground of appeal No.7 is also allowed. The issue in ground of appeal No.8 of benefit of variation of +/- 5% becomes consequential.
24. Now, coming to the balance grounds of appeal raised by the assessee in benchmarking various payments made by the assessee i.e. by way of ground of appeal No.9, payment of royalty, ground of appeal No.10 of payment of technical know-how fees to associate enterprises, ground of appeal No.11 of procurement support services provided to associate enterprises.
25. In the paras hereinabove, we have already held that all these international transactions are to be aggregated and benchmarked in the hands of assessee. Accordingly, we do not adjudicate these issues individually and the Assessing Officer is directed to compute the arm's length price of international transactions and make adjustment, if any, after aggregating international transactions undertaken by the assessee under the head 'manufacturing activity'.
26. By way of ground of appeal No.5, the assessee is aggrieved by the order of TPO in ignoring interest received on extended credit while computing segmental profitability of exports to associate enterprises, since the same is linked to exports to associate enterprises, the same should be considered for ascertaining the segmental profitability of exports to associate enterprises. Accordingly, the grounds of appeal No.5, 9 to 11 are allowed. 32 ITA No.115/PUN/2011
Cummins India Ltd.
27. The next issue raised by the assessee is by way of ground of appeal No.12 against the order of Assessing Officer / TPO in benchmarking the receipt of commission from associate enterprises.
28. Briefly, the facts relating to the issue are that during the year under consideration, the assessee had received commission of Rs.55.54 lakhs from CPG, Kent and CPG, Singapore respectively. The assessee pointed out that it had imported DG sets from CPG, Kent company and sold the same to third parties and had received commission of Rs.14.21 lakhs. As regards the transaction with CPG, Singapore, it was pointed out that the assessee had identified beneficial customers in India and gensets sold directly to third party for which the assessee received commission of Rs.41.33 lakhs. The said income was shown as other income by the assessee. The explanation of assessee was that the amount of commission was dependent upon actual selling price to third party customer and where the customer negotiates the selling price with associate enterprises, then the commission varies. The TPO was of the view that the selling price to the third party depends on customers negotiations with associate enterprises and as such, selling price changes, but not the transfer price to Cummins India Ltd. In other words, the associate enterprises does not compromise on the transfer price and in such circumstances, the justification tendered by the assessee was found to be not acceptable. The TPO noted that there was huge difference in terms of percentage on actual commission received on sales from CPG, Kent, vis-à-vis CPG, Singapore. The TPO thus, applied internal comparable as the basis and proposed adjustment corresponding to the difference of rate of commission which worked out to Rs.43.24 lakhs, which was made to the value of international transactions to arrive at arm's length price of international 33 ITA No.115/PUN/2011 Cummins India Ltd.
transactions relating to receipt of commission from CPG, Kent. The said order of TPO was upheld by the DRP and the assessee is in appeal against the order of Assessing Officer in this regard.
29. The learned Authorized Representative for the assessee pointed out that the approach of TPO was incorrect, wherein international transactions with associate enterprises were benchmarked by comparing the same vis-à-vis another transaction with different associate enterprises. The comparison of controlled transactions with another controlled transaction was held to be not correct. The learned Authorized Representative for the assessee in this regard, placed reliance on the ratio laid down by Mumbai Bench of Tribunal in ACIT Vs. Fuchs Lubricants (India) (P.) Ltd. (2013) 30 taxmann.com 404 (Mumbai - Trib.).
30. The learned Departmental Representative for the Revenue placed reliance on the order of TPO.
31. We have heard the rival contentions and perused the record. The assessee in addition to carrying on of its manufacturing activity had also declared another segment of receipt under the head 'sourcing activity', under which it had declared receipt of commission at Rs.55,54,281/- to be at arm's length price by applying TNNM method as most appropriate method. The assessee had received commission of Rs.14.21 lakhs from CPG, Kent, on sale of imported DG sets and sale to third party customers in India. Further, it had received commission of Rs.41.33 lakhs from CPG, Singapore, wherein the gensets were directly sold by the associate enterprises to third party customers in India, introduced by the assessee. The TPO had benchmarked the transaction by comparing the margins earned by the assessee from associate 34 ITA No.115/PUN/2011 Cummins India Ltd.
enterprises vis-à-vis margins earned from another associate enterprises and made adjustment of Rs.43.24 lakhs. The assessee is aggrieved by the same and the issue which arises in the present appeal is whether the rate of commission realized by the assessee from a transaction with one associate enterprise could be the basis for applying internal CUP for computing the arm's length price of other international transaction with another associate enterprise. The said issue stands covered by similar issue being decided in Tecnimount ICB (P.) Ltd. Vs. ACIT (2011) 11 taxmann.com 49 (Mum.) , (2012) 138 ITD 23/24 taxmann.com 28 (Mum.), wherein the issue was decided and addition was deleted. Applying the said ratio to the issue before us, we hold that there is no merit in the adjustment made by the Assessing Officer / TPO in respect of international transactions relating to receipt of commission from associate enterprises. Accordingly, we direct the Assessing Officer to delete the same and the ground of appeal No.12 raised by the assessee is thus, allowed.
32. The last issue raised by the assessee under the transfer pricing provisions is the adjustment made under the head 'financing activity', wherein the assessee was in receipt of interest for extended credit period facility of Rs.4,00,97,000/-.
33. The assessee had provided extended credit period facility to its associate enterprises for export of IC engines and had charged interest at LIBOR below 290 basis points in case of billing in US Dollars and LIBOR + 280 basis points in case of billing in GB pounds. Credit period was extended by 80 days over and above the original credit period of 90 days allowed to associate 35 ITA No.115/PUN/2011 Cummins India Ltd.
enterprises. The plea of the assessee before the TPO was the benchmarking the said transaction by adopting the rate of interest payable by it by applying the rates of packing credit in foreign currency. The TPO rejected the claim of assessee and made an adjustment of differential amount of interest of Rs.1,41,51,731/-.
34. The learned Authorized Representative for the assessee pointed out that the issue is now stands covered by the ratio laid down by the Pune Bench of Tribunal in iGATE Computer Systems Ltd. Vs. Addl. CIT (2016) 65 Taxmann.com 44 (Pune - Trib.) and in Varroc Engineering (P) Ltd. Vs. ACIT (2015) 54 taxmann.com 384 (Pune - Trib.)
35. We have heard the rival contentions and perused the record. The issue arising before us is in relation to interest charged by the assessee company to its associate enterprises on the outstanding amount due to the assessee, wherein as against credit period of 90 days, the amount was not received for further period of 60 days. Similar issue arose before the Pune Bench of Tribunal in iGATE Computer Systems Ltd. Vs. Addl. CIT (supra) and it was held as under:-
"29. The issue arising before us is in relation to the arm's length price of interest charged by the assessee company to its AEs on the amounts outstanding. The Mumbai Bench of Tribunal in Hinduja Global Solutions Ltd. Vs. Addl.CIT (2013) 145 ITD 361 (Mum) had held that CUP method was the most appropriate method to determine the arm's length rate of interest of the international transaction involving lending of the money by assessee in foreign currency to its AEs and LIBOR being inter-bank rate fixed for international transaction had to be adopted as arm's length rate. The Mumbai Bench of Tribunal further in DCIT Vs. Indian Hotels Co. Ltd. (supra) has applied the said principle in benchmarking the international transaction involving interest charged by the assessee on outstanding loan from its AEs.
30. Further, Pune Bench of Tribunal in Varroc Engineering (P) Ltd. Vs ACIT (supra) had observed as under:-
"15........while benchmarking the international transactions what has to be seen is the comparison between related transactions i.e. where the 36 ITA No.115/PUN/2011 Cummins India Ltd.
assessee has advanced money to its associated enterprises and charged interest then the said transaction is to be compared with a transaction as to what rate the assessee would have charged, if it had extended the loan to the third party in foreign country. Once there is a transaction between the assessee and its associated enterprises in foreign currency, then the transaction would have to be looked upon by applying the commercial principles with regard to the international transactions. In that case, the international rates fixed being LIBOR+ rates would have an application and the domestic prime lending rates would not be applicable. The assessee has further explained that it had raised the loan from Citi Bank on international rates for the purpose of investment in the share application money of its associated enterprises, which in turn was partly converted from capital into loan. Where the assessee had a comparable of borrowing loan on international rates and advancing to its associated enterprises, then the said comparable was to be applied for benchmarking the transaction of advancing the loan on interest to its associated enterprises. The assessee had charged interest rate of 4.75% on the loan advanced to the associated enterprises. The assessee on the other hand, claims that it had borrowed the money on LIBOR+ rates i.e. international rates, which were Japanes based LIBOR+ rates which were lower than the US based LIBOR+ rates. The plea of the assessee before us was that it had advanced the loan to its associated enterprises on LIBOR+ rates i.e. 4.75%. In the totality of the facts and circumstances where the assessee has the internal CUP of operating at international rates available and since the said loan raised by the assessee at international rates was advanced to its associated enterprises, we find no merit in the order of the TPO in applying the domestic loan rates i.e. BPLR rates for benchmarking transaction of charging of interest on the loans advanced to the associated enterprises by the assessee. Where the assessee had made the borrowings on LIBOR+ rates and advanced the same at LIBOR+ rates, then the said transaction is at arm's length price and there is no merit in any adjustment to be made on this account.
16. The Chennai Bench of the Tribunal in M/s. Siva Industries & Holdings Limited Vs. ACIT, Chennai (2012) 26 taxmann.com 96 (Chennai) had held as under:-
"The assessee had given the loan to the associated enterprises in US dollars, and assessee was also receiving interest from the associated enterprises in Indian rupees. Once the transaction between the assessee and the associated enterprises was in foreign currency and the transaction was an international transactions, then the transaction would have to be looked upon the applying the commercial principles in regard to international transactions. If that was so, then the domestic prime lending the rate would have no applicability and the international rate fixed being LIBOR would come into play. In the circumstances, the view that LIBOR rate had to be considered while determining the arm's length price interest rate in respect of the transaction between the assessee and the associated enterprises was to be upheld. As it was noticed that the average of the LIBOR rate for 1-4-2005 to 31-3-2006 is 4.42 per cent and the assessee had charged interest at 6 per cent which was higher than the LIBOR rate, no addition on this account was liable to be made in the hands of the assessee. In the circumstances, the addition made by the Assessing Officer on this count was deleted."37 ITA No.115/PUN/2011
Cummins India Ltd.
17. The Mumbai Bench of the Tribunal in DCIT Vs. Tech Mahindra Ltd. (2011) 12 taxmann.com 132 (Mum.) held that where there is a choice between the interest rate of currency other than the currency in which transaction had taken place and the interest rate in respect of the currency in which transaction has taken place, the latter should be adopted. Where the transaction is between the assessee and its associated enterprises in foreign currency and the transaction is international transaction, then the transaction would have to be looked upon by applying commercial principles in regard to international transactions.
18. Similar principle has been laid down by the Mumbai Bench of the Tribunal in Hinduja Global Solutions Ltd. Vs. ACIT (2013) 35 taxmann.com 348 (Mumbai - Trib.).
19. In the entirety of the above facts and circumstances, we hold that where the assessee had entered into a transaction with its associated enterprises in foreign currency, and the transactions were international transactions, then the same had to be looked into by applying commercial principle in regard to international transactions. In the facts of present case, the assessee had borrowed the loan from Citi Bank and advanced the same on LIBOR+ rates to its associated enterprises, then the said transaction with its associated enterprises is within arm's length price. The TPO / AO thus, directed to re-compute the arm's length price of the international transactions. Another aspect to be kept in mind is the plea of the assessee with regard to the interest receivable. The assessee had also raised the issue that the TPO had adopted the interest receivable from associated enterprise company at Rs.2,86,27,089/- instead of Rs.2,91,82,060/- which is disclosed in the audit report in Form No.3CEB. The Assessing Officer is also directed to verify the claim of the assessee in this regard and compute the arm's length price of the international transactions. Reasonable opportunity of being heard shall be afforded to the assessee by the Assessing Officer / Transfer Pricing Officer. The grounds of appeal Nos.1 and 2 rai sed by the assessee are thus, allowed as indicated above."
31. The learned Departmental Representative for the Revenue placed reliance on the ratio laid down by the Delhi Bench of Tribunal in Cheil India (P.) Ltd. Vs. DCIT (supra). We find no merit in the said reliance placed upon by the learned Departmental Representative for the Revenue where it was directed that the interest should be computed on the basis of SBI base rate plus 150 basis points on the amount outstanding from the debtors. On the other hand, Pune Bench of Tribunal in Varroc Engineering (P) Ltd. Vs ACIT (supra) and other Benches of the Tribunal have upheld the application of international rates of interest to be applied for benchmarking the international transactions.
32. The assessee in the present set of facts was carrying on its business with its AEs and the majority of business receipts were receivable from the AEs. Once the transaction between the assessee and its AEs was in foreign currency, then the same part takes the nature of international transaction and the said transactions have to be looked upon by applying the commercial principles with regard to an international transaction. If that is so, then the domestic lending rates cannot be applied in order to benchmark the transaction of the assessee with its AEs and the international rates fixed by LIBOR would come into play. There was substantial delay in receipt of payment from AEs and substantial amount stood unrecovered from the AEs beyond the stipulated periods. The assessee initially did not charge interest from the AEs and subsequently, charged interest from AEs at AFR i.e. American Federal Rate @ 2.98%. The amount is in the character of loan or borrowing after the stipulated 38 ITA No.115/PUN/2011 Cummins India Ltd.
credit period and consequently, such recovery of dues in the international transaction with its AEs is to be benchmarked by applying CUP method of international bank rates. Accordingly, we hold that LIBOR plus rates have to be applied to the amounts due from the AEs beyond the period of 25 days, which was the weighted average number of days delay allowed to the third parties. After excluding the period of 25 days, interest is to be charged on the balance number of days of delay by applying LIBOR plus rates. We find that the TPO had applied average rate of LIBOR plus 300 basis points as the reasonable rate of interest, which the assessee should have charged to its AEs. The TPO had also charged plus 200 basis points as guaranteed commission. The CIT(A) has given a finding that in the absence of any expenditure having been incurred by the assessee on such guaranteed commission, there was no merit in including the same. The Revenue is not in appeal against the said finding of the CIT(A) and in the totality of the above said facts and circumstances, where it has not been established that the assessee has not paid any commission, there was no merit in charging plus 200 basis as guaranteed commission. However, we uphold the order of TPO in benchmarking the transaction of interest due on amounts outstanding from its AEs at LIBOR plus 300 basis points. The Assessing Officer / TPO shall determine the adjustment, if any, to be made in the hands of assessee on account of interest chargeable on the amounts due from its AEs beyond the credit period of 25 days after allowing the benefit of interest recovered by the assessee from its AEs. The grounds of appeal raised by the assessee are thus, partly allowed."
36. Following the same parity of reasoning, we hold that LIBOR + rates have to be applied to the amounts due from associate enterprises for the extended period of credit and the extended period of credit. The Assessing Officer is directed to follow our directions in iGATE Computer Systems Ltd. Vs. Addl. CIT (supra) to adjudicate the issue after affording reasonable opportunity to the assessee.
37. Now coming to the corporate issues raised by the assessee, the Ld. Authorised Representative for the assessee pointed out that Ground of appeal No.18 against disallowance out of depreciation of intangibles is not pressed, hence the same is dismissed as 'not pressed'. Ground of appeal No.19 against initiation of penalty proceedings is premature and hence the same is also dismissed.
38. The issue by way of Ground of appeal No.14 raised by the assessee is against disallowance of incremental provision for New Engine Performance Inspection Fee (in short "NEPI Fee').
39ITA No.115/PUN/2011
Cummins India Ltd.
39. Brief facts relating to the issue are that during the year under consideration the assessee had made incremental provision for NEPI fees to the tune of Rs.1,31,18,000/-. The assessee was show-caused to explain as to why said fees should not be disallowed as in the earlier years. The assessee admitted that the facts of the present case were identical to the earlier years and the deduction should be allowed as the IC Engines sold by the assessee include the consideration towards free inspection. The assessee submitted the details of gross provision made, the amounts payable and the reversals done for the preceding three years and for the year under consideration which are tabulated at page 4 of the final assessment order passed under section143(3) read with section 144C(13) of the Act. The Assessing Officer was of the view that the utilization, i.e. actual expenditure of any fee was much lesser than the provision made for the respective years and excess provision was consistently being made over the years, which led to need for reversal in the succeeding years. Following the earlier years decision, the Assessing Officer proposed disallowance of Rs.1.31 crores against which the assessee filed objections before the Dispute Resolution Panel, which rejected the same. The Assessing Officer thus added the said amount as income of the assessee.
40. The Ld. Authorised Representative for the assessee pointed out that the said issue is covered by the order of the Tribunal in assessee's own case relating to Assessment Year 1994 -95 and also no addition has been made by the Dispute Resolution Panel itself in Assessment Year 2007 -08.
41. The Ld. Departmental Representative for the Revenue placed reliance on the order of the Assessing Officer.
40ITA No.115/PUN/2011
Cummins India Ltd.
42. We have heard the rival contentions and perused the record. The assessee was engaged in the manufacture and sale of IC Engines which had wide applications. The assessee was offering free servicing and free inspection of the equipment for certain initial running of the equipment. The assessee was following a system under which the inspection checks were being carried out at different intervals as in the following manner :
Inspection Period of Interval Checks A At putting engine into service OR at 50 hours or 1 month of engine operation whichever is earlier B At 250 hours OR 6 months of engine operation whichever is earlier C At 1500 hours OR 1 year of engine operation whichever is earlier D At 4500 hours OR 2 years of engine operation whichever is earlier
43. The inspections carried out by the assessee was to check the performance of IC Engines and such services were vital business requirements. The assessee pointed out that these inspections to the end user were being provided under contractual obligation since the products manufactured by the assessee were technically complex and considering its usage there was necessity to provide such inspection and servicing for certain specific period, after the equipment was commissioned. The assessee also claims that the selling price fixed by it includes the element of inspection to be offered and thus under the principles of matching costs and revenue, all the costs associated with revenue have to be recognized in the year, in which the revenue was recognized.
44. From the perusal of details, it transpires that the assessee was following a scientific basis for making the aforesaid provision which is not a contingent expenditure as the provision is made in relation to the IC Engines sold by the 41 ITA No.115/PUN/2011 Cummins India Ltd.
assessee. The assessee no doubt is making the provision and after the lapse of the period of inspection in case the expenditure has not been necessitated then the same is written back. In the totality of the above said facts and circumstances, we find merit in the plea of the assessee and allow the claim of the provision made for any NEPI fee. It may also be pointed out that the inspection and servicing is different from warranty which is to be taken care of in case of failure of the Engine or its Components during the period of warranty. Accordingly, we allow the claim of the assessee. The Ground of appeal No.14 is thus allowed.
45. The assessee by way of Ground of appeal No.16 is also aggrieved by the disallowance of incremental warranty provision of Rs.4,41,28,000/-. The assessee as in the case of NEPI fee is also maintaining a scientific basis for making the said provision and its utilization and thereafter its write back. The said expenditure has been disallowed by the authorities below on the ground that the assessee has not utilized the total provision and has written back the amount.
46. We find no merit in the stand of the authorities below in this regard wherein the assessee is following a scientific basis in claiming the said expenditure and as in the case of NEPI fee, the provision made by assessee is to be allowed as the amount is relatable to the IC Engines sold by the assessee. The warranty clause is part of the contractual obligations of the assessee and the same is an ascertained liability being determined on a scientific basis and hence the same is to be allowed as an expenditure in the hands of the assessee. We hold so and allow Ground of appeal No.16 raised by the assessee.
42ITA No.115/PUN/2011
Cummins India Ltd.
47. Now coming to Ground of appeal No.15 raised by the assessee which is against disallowance of expenses u/s.14A of the Act, the assessee during the year under consideration had received interest and dividend of Rs.36.81 crores from shares in different companies and units of mutual funds and had shown long term capital gain of Rs.1.62 crores. All these items of income were exempt from tax and the Assessing Officer invoked the provisions of section 14A read with Rule 8D of the Income Tax Rules and worked out the disallowance in the hands of the assessee to the tune of Rs.15,94,740/-.
48. The assessee is aggrieved by the aforesaid disallowance. The first contention raised by the assessee before us is that the year under consideration is Assessment Year 2006 -07 and in the said year, the provision of Rule 8D of the Income Tax Rules were not applicable. He further pointed out that the assessee has sufficient reserves and surplus and current income, to make the aforesaid investments out of which majority of the investments are strategic investments and the income from the strategic investments made by the assessee in sister concerns or related concerns is to the tune of 78.52%. The Ld. Authorised Representative for the assessee also pointed out that similar disallowance under section 14A of the Act was made in Assessment Year 2005-06 wherein the Tribunal (order dated 29-01-2016) held that the provisions of Rule 8D were not applicable and disallowance on account of administrative expenses to the tune of Rs.2 lakhs was made in the hands of the assessee.
49. The Ld. Departmental Representative for the revenue placed reliance on the orders of the authorities below.
43ITA No.115/PUN/2011
Cummins India Ltd.
50. We have heard the rival contentions and perused the record. The issue which arises in this ground is against disallowance under section 14A of the Act. The year under appeal is Assessment Year 2006 -07 and the provisions of Rule 8D of the Income Tax Rules do not apply to the instant assessment year and hence we find no merit in the orders of the Assessing Officer/Transfer Pricing Officer in invoking the said rule. Further, the assessee has sufficient income for the year under consideration and also sufficient reserves and surplus to make the investments, income from which is exempt from tax. The assessee has also made investments in sister concerns and other related concerns which are strategic investments made while carrying on its business and 78.51% of the total exempt income is earned from such strategic investments. In the totality of the above said facts and circumstances and following the ratio laid down by the Tribunal in assessee's own case in Assessment Year 2005 -06 (order dated 29-01-2016) we hold that no disallowance out of interest expenditure is to be made in the hands of assessee as the assessee has sufficient funds and even otherwise the provisions of Rule 8D are not applicable to the instant assessment year. Now coming to the administrative expenses, following the precedent in assessee's own case, we restrict the disallowance to Rs.2 lakhs. Accordingly, grounds of appeal No.15 raised by the assessee is partly allowed.
51. The last issue raised by the assessee is against re-working of deduction under section 80IB of the Act vide Ground of appeal No.17.
52. Brief facts relating to the issue raised are that the assessee was running a unit at Daman for the manufacture of LHPC Engines, against which the assessee had claimed deduction under section 80IB of the Act at Rs.6.55 44 ITA No.115/PUN/2011 Cummins India Ltd.
crores. The assessee was asked to submit the profit and loss account of Daman unit and also to state whether the head office expenses, i.e. Directors salary, sitting fee and commission etc., were allocated to the Daman unit. The plea of the assessee before the authorities below was that the said unit was functioning as a separate business unit and as its own employees were looking after the operations, none of the expenses of the other division including the head office could be attributed or allocated to the activities of the eligible industrial undertaking. Without prejudice to its submission, the assessee also submitted the details of directors salary, sitting fees and commission amounting to Rs.53,79,161/- and estimated the directors travelling expenses at Rs.17,15,000/-. The plea of the assessee before the Assessing Officer/Transfer Pricing Officer was that none of the said expenses could be attributed to the activities of the eligible industrial undertaking. The contention of the assessee was not accepted and proportionate expenses were allocated and the eligible profits of the undertaking were recomputed by reducing the same at Rs.11,19,532/- and deduction under section 80IB of the Act @30% was re-worked resulting in disallowance of Rs.3,35,860/-. The proposal made by the Transfer Pricing Officer was modified by the Dispute Resolution Panel regarding the maintenance expenses incurred in the head office to be adopted as per the actual figures. Considering the same the eligible profits of the industrial undertaking were reduced by Rs.9,81,218/- and the deduction under section 80IB of the Act was reduced by Rs.2,94,365/-. The assessee is in appeal against the same.
53. The Ld. Authorised Representative for the assessee could not controvert the findings of the Assessing Officer. In t he totality of the facts and circumstances of the case, even though the Daman unit was working 45 ITA No.115/PUN/2011 Cummins India Ltd.
independently, but there is merit in the orders of the authorities below in allocating the directors expenses and part of administrative expenses to the eligible industrial undertaking and re-work the deduction under section 80IB of the Act. Upholding the same we dismiss the Ground of appeal No.17 raised by the assessee.
54. In the result, the appeal of the assessee is partly allowed.
Order pronounced on this 3rd day of March, 2017.
Sd/- Sd/-
(R.K. PANDA) (SUSHMA CHOWLA)
लेखा सद�य / ACCOUNTANT MEMBER �या�यक सद�य / JUDICIAL MEMBER
पुणे / Pune; �दनांक Dated : 3rd March, 2017.
GCVSR
आदे श क� ��त�ल�प अ�े�षत/Copy of the Order is forwarded to :
1. The Appellant;
2. The Respondent;
3. The DIT (Intl. Taxation), Pune ;
4. The DRP, Pune ;
5. The DR 'A', ITAT, Pune;
6. Guard file.
आदे शानुसार/ BY ORDER, स�या�पत ��त //True Copy // सहायक पंजीकार / Assistant Registrar, आयकर अपील�य अ�धकरण, पुणे / ITAT, Pune